I wanted to get back to basics today and talk about two investing strategies that every investor should be aware of and practice when searching for new opportunities.
When a market is fiscally healthy, some analysts recommend you use a top-down approach to investing. Find the strongest industries and then the best companies within.
On the other hand, if the markets are depressing, using the opposite could work… a bottom-up approach. Find the single company that is doing well and invest in it.
Both approaches are fundamental in nature and a good starting point for when you first evaluate an investment opportunity. From there, you can then move onto a more detailed analysis on both short-term benefits and long-term trends.
The first strategy is known as a top-down approach, or what I like to call a macro view. This takes into consideration geographics, geopolitics, sectors and economic trends.
Most commonly known as the “big picture” approach, an investor using this strategy would take a macro view of the global economy to dissect what industries and international markets will outperform.
The idea is that by understanding current market trends; you can find the top performing industries, basically separate the weak from the strong.
Once you find the best industries, you go from the top-down to decide which are the best stocks in the industry. Pretty straight forward.
The advantage of using a system like this is you will be able to ride along current trends by investing in only the best sectors at the best times… think short-term investing. Each quarter you can reevaluate and invest accordingly.
A good way to begin is to follow the daily industry leaders and laggards composite averages, where you can follow overall monthly performances and get a pretty good idea of which industries are on top at any given time.
The opposite approach is the bottom-up strategy, or micro view. As you can probably surmise from the name, this approach frowns upon the global economic view and tends to believe that individual companies, regardless of what industry they’re in, can outperform.
By disregarding economic cycles these investors believe that a strong company with growing fundamentals can outperform their peers, even if the industry they’re in is down.
It entails a thorough review of the company, their products and services, and earnings potential.
Using this strategy can be beneficial because while micro in focus, you avoid macro-economic trends influencing your ability to find strong companies.
In this volatile market, it’s the best approach, in my opinion, to find strong companies in the short-term. As I like say: find them, profit from them, and forget them.
For example, a particular company in a fledgling industry is about to report earnings and your research points to them outperforming – this would be a good short-term investment.
On the other hand, if a specific company has a growing trend of accelerating earnings, it might be a good long-term investment, but be mindful… because economic conditions could continue to be volatile and change the company’s earnings potential over time.
At the end of the day, both are solid beginning approaches to investing. With the top-down approach you’re focusing on the best global industries, and with the bottom-up strategy, you look for only the best companies.
If used in tandem, you might come to the same conclusion on an individual stock, which would be a great way to confirm that a stock is a sound investment.
In this market today, I would recommend using a bottom-up approach – let the strong survive.